The U.S. government will offer hundreds of billions of dollars in equity and loan guarantees to investors who bid against one another to buy troubled assets from banks, officials said today.

The "Public Private Investment Plan" detailed this morning, a long-awaited but risky piece of the government's financial stabilization strategy, will pour government money into private investment funds as a way to move loans from the balance sheets of banks to those of long-term investors.

Under the plan, the government and private investors will invest together to buy up between $500 billion and $1 trillion worth of real estate-related loans and securities from banks. The government will use up to $100 billion from the Troubled Assets Relief Program, matched by private funds, to capitalize the purchases.

The hope is that instead of hoarding cash in case those assets continue to lose value, banks will resume lending money once the toxic assets are off their books.

The government and private investors, meanwhile, will hold the assets for the long term, and stand to either make or lose money depending on how the economy does.

Why was I so quick to condemn the Geithner plan? Because it’s not new; it’s just another version of an idea that keeps coming up and keeps being refuted. It’s basically a thinly disguised version of the same plan Henry Paulson announced way back in September. To understand the issue, let me offer some background.

Start with the question: how do banks fail? A bank, broadly defined, is any institution that borrows short and lends long. Like any leveraged investor, a bank can fail if it has made bad investments — if the value of its assets falls below the value of its liabilities, bye bye bank.

But banks can also fail even if they haven’t been bad investors: if, for some reason, many of those they’ve borrowed from (e.g., but not only, depositors) demand their money back at once, the bank can be forced to sell assets at fire sale prices, so that assets that would have been worth more than liabilities in normal conditions end up not being enough to cover the bank’s debts. And this opens up the possibility of a self-fulfilling panic: people may demand their money back, not because they think the bank has made bad investments, but simply because they think other people will demand their money back.

Bank runs can be contagious; partly that’s for psychological reasons, partly because banks tend to invest in similar assets, so one bank’s fire sale depresses another bank’s net worth.

So now we have a bank crisis. Is it the result of fundamentally bad investment, or is it because of a self-fulfilling panic?

If you think it’s just a panic, then the government can pull a magic trick: by stepping in to buy the assets banks are selling, it can make banks look solvent again, and end the run. Yippee! And sometimes that really does work.

But if you think that the banks really, really have made lousy investments, this won’t work at all; it will simply be a waste of taxpayer money. To keep the banks operating, you need to provide a real backstop — you need to guarantee their debts, and seize ownership of those banks that don’t have enough assets to cover their debts; that’s the Swedish solution, it’s what we eventually did with our own S&Ls.

Now, early on in this crisis, it was possible to argue that it was mainly a panic. But at this point, that’s an indefensible position. Banks and other highly leveraged institutions collectively made a huge bet that the normal rules for house prices and sustainable levels of consumer debt no longer applied; they were wrong. Time for a Swedish solution.

But Treasury is still clinging to the idea that this is just a panic attack, and that all it needs to do is calm the markets by buying up a bunch of troubled assets. Actually, that’s not quite it: the Obama administration has apparently made the judgment that there would be a public outcry if it announced a straightforward plan along these lines, so it has produced what Yves Smith calls “a lot of bells and whistles to finesse the fact that the government will wind up paying well above market for [I don't think I can finish this on a Times blog]”

Why am I so vehement about this? Because I’m afraid that this will be the administration’s only shot — that if the first bank plan is an abject failure, it won’t have the political capital for a second. So it’s just horrifying that Obama — and yes, the buck stops there — has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.

If I'm right and the mortgages are largely trash, then the Geithner plan is a Rube Goldberg device for shifting inevitable losses from the banks to the Treasury, preserving the big banks and their incumbent management in all their dysfunctional glory. The cost will be continued vast over-capacity in banking, and a consequent weakening of the remaining, smaller, better- managed banks who didn't participate in the garbage-loan frenzy.

If the NYT description of the Treasury Department's bank rescue plan is accurate, then this should have been the headline to the article. The article reports that the Treasury Department is confident that it will not lose money by buying mortgage backed securities at far above their market price because: "the government can hold those mortgages as long as it wants, officials are betting the government will be repaid and that taxpayers may even earn a profit if the market value of the loans climbs in the years to come."

House prices are currently falling at more than a 20 percent annual rate. If they fall another 20 percent in real terms, they will be back at their trend level. A further 20 percent decline will hugely increase the percentage of mortgages that are underwater, reducing the value of mortgage backed securities from their current level. There is no obvious reason that house prices should then again rise above their trend level.

The failure of people like Ben Bernanke and Timothy Geithner to recognize the $8 trillion housing bubble led to this crisis. It appears as though they somehow still don't understand it. This fact should have been the headline of the news article since their continued failure to understand the housing market could cost taxpayers trillions of dollars and further damage the economy.

Atrios (While he writes things in a much funnier way, don't forget that he has PhD in economics):

People are spending too much time trying to make sense of a plan which doesn't make much sense, certainly not as advertised.

The Geithner plan will:

1) Funnel more government money to the banksters.2) Allow the banksters to pretend for a bit longer that their hunks of big shitpile aren't quite as shitty as we thought by using the bullshit price that this process comes up with, allowing too big to fail businesses to stay in business for a bit longer.

This might make sense if you truly believe the magic market you believe in fervently is genuinely incorrectly pricing the assets, perhaps because you genuinely believe that if you could turn around the economy fast enough that you could massively reduce expected foreclosures.

But if you genuinely believe that, I don't think you've been paying too much attention to just what's been going on in the housing market. I don't think you paid too much attention 3 years ago when you didn't realize that it didn't quite make sense that so many people could afford $700,000+ homes in Orange County. I don't think you paid too much attention to the degree of speculation and outright fraud that was happening in parts of the country.

Lacking relevant policy expertise, I am not going to pretend that I can determine whether Krugman or DeLong is correct. And even if I had the expertise, economics is a field of study where, like all areas of social science, "experts" disagree with each other all the time. So, no matter if you are in the "nuh-uh" or "ya-huh" camp on this one, it isn't hard to find someone smarter than you, and more well-versed in economics than you, who agrees with you. So expertise and smarts aren't really the main sources of disagreement in this case. People don't disagree with you just because they don't know what they are talking about.

Instead, disagreement in this case comes down to a more fundamental, personal disposition. Do you trust the people running the financial sector, or not? Do you think that the current crisis was simply a blip in an otherwise well-functioning economic financial system?

Personally, I don't trust it. I don't think the people running the financial system have anyone but their own best interest at heart. Further, I don't think that what is good for them has ended up being good for us. I don't think there is anything stopping them from ripping us off with taxpayer money the way they ripped us off with 401k money. I don't think there is anything stopping them from just making more bad assets that sink us, while they get rich. My belief is that we need to impose stricter limits on executive compensation, place increased restrictions on financial speculation, and to reorganize government spending and create a much larger, non-bailout and non-military oriented public sector in a way that protects us from these financial speculation bubbles. Whether or not the bailout plan will work, this should prevent us from ever getting into this situation again.

Sorry for the extensive quoting, but I wanted to get it all out there. While no plans are a guaranteed success, this just seems like a much riskier strategy than was required. And even if the plan works, I'm not a fan of using taxpayer money to cover the asses of same people who were gambling our money away in the first place. In this plan none of those people lose their jobs, in fact they are essientially rewarded for their actions.

I liked the section in Geithner's speech about regulation, but like Chris Bowers said it seems to be a bit backwards. You give them piles of money to keep the current system in place, AND THEN you come up with a plan for new "sweeping" regulations? Wouldn't you put in the new sweeping regulations, and then hand them piles of money? What's stopping these people from taking our money and engaging in the same risky behavior? They clearly don't have a problem buying new jets or throwing lavish parties while we're propping up their businesses and they know they're under the microscope - so why would any of that suddently change?

To paraphrase Dean Baker, if Geithner isn't smart enough to resolve the banking crisis without enriching those who gave us the banking crisis, then he proably shouldn't be Tresury Secretary.

3 comments:

hey, where are all the witty remarks and accusations that we're socialists on this post? i guess it was too long and coherent for any of the resistnetters to read all the way through? did you guys even read any of this? you're all so busy telling us what we are and calling us names to even read anything we write or have to say

I think the reason the resistneters aren't calling you socialists on the comments section of this one is A) no one called them idiots in this postand B) You're criticizing the Obama administration in this post

But yeah, it's funny that none of them seem to take notice of this type of post when they comment on JN's "field trips". Probably they're just fed links that only lead to one at a time...